Prices in the stock market are continually swinging between periods of consolidation and expansion, creating a repeating cycle of trending and range-bound price action. Stock traders can use technical indicators best suited to either market condition to gain deeper insight into the strength and direction of trends in expansion periods or the boundaries of a price range during a consolidation. Knowing when to use ranging indicators and trend indicators in the stock market, as well as choosing the right indicators to use, can provide you with valuable information for making trading decisions.
Trend indicators are most useful in trending markets and become much less useful in periods of price consolidation with low volatility. In technical analysis, a trending market can be defined as one in which market prices are making higher highs and higher lows in an uptrend or lower highs and lower lows in a downtrend. Trending indicators can help not only to determine the direction of a trending market but also the momentum of price movements and the most likely points of retracement -- the points at which a trend will temporarily turn in the opposite direction as traders take profit on their trend-based trades.
Ranging indicators are most useful in periods of price consolidation, or range-bound markets. Just like trending indicators, ranging indicators become much less useful in the opposite market condition. A range-bound market is one in which prices turn around at the same points repeatedly, creating clear areas of support and resistance and forming a clearly defined range. Ranging indicators can help you define the strongest support and resistance zones within a range and determine when and in which direction the price is likely to break out of the range.
Moving average indicators provide a foundation for other trending indicators. Simple or exponential moving averages can display a short-, medium- or long-term trend as a single line on a chart. Using multiple moving averages with different settings can reveal the interplay between current trends in different time frames. Bollinger bands combine a moving average with an indicator displaying two standard deviations above and below the average. Bollinger bands not only reveal a trend direction, but they also show the highest and lowest average swing points for reversals and continuation moves within a larger trend. The MACD -- or moving average convergence/divergence -- indicator can reveal the point at which a trend is most likely to reverse by analyzing moving averages more deeply.
Pivot points form the basis for ranging indicators. A pivot is defined as a past period on a chart that closes above the two prior and subsequent periods for an upper pivot or below the two prior and subsequent periods on a lower pivot. Pivot point indicators calculate and display the technical pivots on a chart, allowing investors to quickly identify likely ranges in consolidation periods. Momentum-based indicators, such as a stochastic oscillator and the relative strength index, or RSI, can help you to pinpoint moments of unusually high momentum within a range that can reveal the points at which price is primed to break out of a consolidation zone and head back into a trend. The term "stochastic" simply refers to a system in which one or more variables is uncontrollable, and "oscillator" refers to any indicator whose visible output moves back and forth between an upper and a lower range. Both stochastics and RSI are considered momentum-based oscillators. As the line begins to move downward from the upper range, it can signal that the price is likely to drop soon, and as the line moves upward from the lower range, it can signal the opposite.
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